The reason Cameron is wrong in humiliating energy tariff debacle

IT IS always disappointing for politicians when a confused announcement turns a popular idea into a communications disaster. George Osborne experienced that pain earlier this year when he announced a freeze in fuel duty and, thanks to the timing, the front pages the next days were about U-turns and not lower taxes. At Prime Minister’s Questions this week, the Prime Minister announced that the government would “be legislating so that energy companies have to give the lowest tariff to their customers”.

The press has been absolutely scathing. Ministers have refused to admit he simply misspoke and tried to pretend that he simply restated a far more moderate policy announced earlier by Nick Clegg. That policy was, although so far unclear, to encourage firms to offer lower prices, particularly to vulnerable customers.

The basic concern is that few customers switch their energy supplier. As anyone who has ever shopped around for mobile phone contracts will know, throwing your weight around as a consumer normally results in a better deal. And, if you ask, there may be a deal that better reflects your habits as a consumer so you pay a lower price.

The basic idea behind the government’s plan is to force the energy companies to pretend you are shopping around. Stop them discriminating between the most and least discerning customers. Forcing companies to pretend there is greater competition than there actually is marks a departure from the approach taken in areas like banking, where the aim is to try to make it easier for people to switch.

But the problem is that margins in the retail sector just aren’t that big a deal. They fluctuate, but the latest estimate of the rolling net margin on a dual fuel customer is £45 a year. That is about 3 per cent of a typical £1,310 bill. Even if they can drive companies to cut retail margins massively, the difference it will make to family budgets will be limited.

By contrast, wholesale gas prices, environmental regulations and VAT (even at the lower rate applied to domestic heat and power) are far more important. If the government really wants to help families struggling with their energy bills, they could do something about that.

Wholesale gas prices have fallen sharply in the United States with the development of shale gas. The Institute of Directors recently released a major report setting out the difference it has made. From a 2005 low, the production of natural gas in the United States has increased by 28 per cent. Most of that is shale, with production increasing from 0.39 trillion cubic feet in 2000 to around 5 trillion cubic feet in 2010. Natural gas prices there are now around a third of those in the UK.

We don’t know for sure if shale gas can deliver the same returns here. Estimates are uncertain. In 2010, the British Geological Survey estimated the UK’s onshore shale reserves at 5.3 trillion cubic feet. But according to the Institute of Directors they are set to revise that up later this year, potentially as high as 200 trillion cubic feet. Owen Paterson’s commitment, as secretary of state at the Department for Environment, to speed the development of shale gas is a far more meaningful contribution to lower energy prices than trying to force down energy sector margins.

But even if he succeeds, energy targets are set to add a lot more to energy prices over the rest of this decade. Britain will struggle to meet the toughest target in the European Union to increase the use of renewable energy by 2020. If we persist with that target, it will mean a lot more extremely expensive offshore wind and add a huge amount to bills.

In September 2010, Citigroup estimated that Britain would have to invest €229bn (£186bn) to meet environmental targets, against just €91 billion for the natural replacement and renewable of ageing infrastructure. By contrast, to meet environmental targets Germany would only have to invest €87bn and France just €60bn. Paying for all that investment will require higher prices. If politicians don’t make a clear decision and ditch the renewable energy target, we will all end up with the bill.

The real mistake of the energy companies, the criticism they really deserve, is that they supported all of the energy policies that have created this huge need to invest. It could easily be their own downfall as political pressures build towards fresh demands for a windfall tax. Cameron’s confusion is just a small part of that ugly political process.